When it comes to defined contribution (DC) plans, it is critical for plan sponsors to offer a diverse selection of investment options covering a full range of asset classes. However, it is also important to understand the differences between active and passive strategies, especially for fixed income.

Whether you are looking at core menu options or target date strategies for your plan, it is important to understand how the fixed income investments you choose to offer participants are managed.

While some plan sponsors (and participants) may opt for passive fixed income investments, they may not always deliver the outcomes participants expect from their fixed income allocations, including diversification and potential return enhancement. In addition, passive investors are vulnerable to the changing investment characteristics of fixed income indices and could miss out on the benefits of exposure to securities and sectors that are not represented in a given index, especially in volatile interest rate environments.

Actively managed fixed income investments can help participants construct strong, well-diversified portfolios. Skilled and experienced active managers have the tools to inform security selection, identify return-enhancing opportunities and manage duration and risk – as well as the flexibility to respond to ever-changing markets.

The case for active fixed income

In our view, passive fixed income strategies can attempt to mimic an index, but on their own they may not lead to all the outcomes that investors traditionally expect from their fixed income allocations, including enhanced returns, lower volatility and diversification. As a reminder, the largest holdings in a fixed income index are those that issue the most debt. Do investors inherently want their largest holdings to be the largest borrowers? In an environment of rising rates in conjunction with increased market volatility globally, active, flexible decision-making is even more critical to portfolio performance in a changing economic environment.

Greater diversification

While the S&P 500 Index captures more than 80% of the U.S. stock market, bond indices are less reflective of the markets they seek to emulate. The benchmark for U.S. investment-grade bonds, the Bloomberg US Aggregate Bond Index (also known as “the Agg”), captures only 49% of the U.S. bond market. Diversified core fixed income investors need to be aware that the Agg remains highly concentrated in U.S. Treasury and agency mortgage-backed securities (MBS), which represent almost 70% of its underlying assets. The index’s rule-based construction, designed in the 1980s, excludes many securities that investors prefer to deploy in a modern, well-diversified portfolio: certain agency mortgage securities, most asset-backed securities and approximately 40% of all corporate bonds.

The Agg excludes large parts of the U.S. bond market

Source: Bloomberg, J.P. Morgan Asset Management; data as of 12/31/21 (latest data available). Data represents Bloomberg US Aggregate Bond Index.

Investors seeking broader market diversification need to look beyond the rigidity of the Agg for exposure to a more complete set of opportunities – and access to sectors such as asset-backed securities, high yield bonds and emerging market debt – to potentially generate additional income and return.

Ability to make active decisions

The current interest rate environment is an excellent example of why flexibility to make active decisions is critical. Since passively managed funds are designed to track an index, there is no opportunity to make active decisions, such as making tactical allocations as well as managing duration and risk.

Last year when rates were rising, active investment managers had the flexibility to lower duration versus the Agg to mitigate declining bond prices. Depending on the fund’s objectives and guidelines, managers may have also had the flexibility to upgrade credit quality, increase liquidity profile and capture yield by allocating to other sectors of the fixed income market.

Enhanced returns

Active fixed income management has shown its ability to deliver excess returns net of fees – a fact that may surprise some staunch advocates of passive investing in equities. Within each of the two largest bond fund categories – core bond and core-plus bond – the JPMorgan Core Bond and Core Plus Bond Funds outperformed the Agg as well as the average passive core bond fund over various economic cycles.

In addition, not only do active fixed income managers outperform their passive peers net of fees over the long term, they have also outperformed on a risk-adjusted basis, meaning lower volatility with higher Sharpe ratios.

Within the largest bond categories, active management has added value

Excess annualized return (%) over the Bloomberg US Aggregate Bond Index

Source: Morningstar, J.P. Morgan Asset Management analysis; as of 3/31/23. Analysis for the average passive core fund includes funds in the Morningstar intermediate core category with a primary prospectus benchmark of the Bloomberg US Aggregate Bond Index. Only includes institutional or no-load share classes as defined by Morningstar. Past performance is not indicative of future returns.

Building stronger retirement plans

With the crosscurrents of volatile rates and the possibility of persistently higher inflation combined with a slowing economy, active fixed income managers continue to see ample opportunities to enhance portfolio returns and mitigate risks.

Plan sponsors and advisors have the freedom to choose from an expanding array of both active and passive fixed income approaches – from core strategies that provide diversification to equity exposures, to complementary strategies that reduce overall portfolio risk, to sector strategies that enhance income and total return. The key is to understand what is really beneath the hood of both an active or a passive strategy – or a blended approach, in the case of target date funds – and whether that strategy has the ability to flexibly navigate changing market conditions.

Within our SmartRetirement target date funds, leveraging active managers for our underlying fixed income strategies – specifically JPMorgan Core Bond Fund and JPMorgan Core Plus Bond Fund as well as our high yield and emerging markets debt strategies – can help us generate more efficient risk-adjusted returns with the potential to both mitigate volatility on the downside and lead to better income replacement outcomes.

With increased sensitivity to fees, we understand providers are looking for lower cost alternatives in the target date space. The JPMorgan SmartRetirement Blend Funds combine both active and passive strategies, while leveraging the same glide path, asset allocation expertise and risk management process used for our actively managed target date funds.

Core Bond Fund (R6 shares)

Quarterly performance (as of 9/30/2023)

*Fund performance inception: 12/31/1983

The quoted performance of the Fund includes performance of a predecessor fund/share class prior to the Fund's commencement of operations. Please refer to the current prospectus for further information.

Effective November 22, 2017, the calendar year performance of the share class was recalculated to take into consideration the expenses of the new share class.

Mutual funds have fees that reduce their performance: indexes do not. You cannot invest directly in an index.

Core Plus Bond Fund (R6 shares)

Quarterly performance (as of 9/30/2023)

*Fund performance inception: 3/5/1993

The quoted performance of the Fund includes performance of a predecessor fund/share class prior to the Fund's commencement of operations. Please refer to the current prospectus for further information.

Effective November 22, 2017, the calendar year performance of the share class was recalculated to take into consideration the expenses of the new share class.

Mutual funds have fees that reduce their performance: indexes do not. You cannot invest directly in an index.

Performance quoted is past performance and is no guarantee of future results. Investment returns and principal value will fluctuate, so shares, when sold, may be worth more or less than original cost. Current performance may be higher or lower than returns shown. Call 1-800-480-4111 for most recent month-end performance.

Mutual funds have fees that reduce their performance; indexes do not. You cannot invest directly in an index. The Bloomberg U.S. Aggregate Index is an unmanaged index representing SEC-registered taxable and dollar-denominated securities. It covers the U.S. investment-grade fixed rate bond market, with index components for government and corporate securities, mortgage pass-through, and asset-backed securities.

Investing involves risk, including possible loss of principal. Investment returns and principal value of an investment will fluctuate so that an investor’s shares, when sold or redeemed, may be worth more or less than their original cost. Brokerage commissions will reduce returns.

Actively managed funds typically charge more than index-linked products. Asset allocation/diversification does not guarantee investment returns and does not eliminate the risk of loss.

Investments in bonds and other debt securities will change in value based on changes in interest rates. If rates rise, the value of these investments generally drops.

Target Date Funds (TDFs) may suffer investment losses, including near and following retirement. There is no guarantee that a TDF will provide adequate retirement income.

The JPMorgan SmartRetirement Funds are TDFs with the target date being the approximate date when investors plan to retire. Generally, the asset allocation of each Fund will change on an annual basis with the asset allocation becoming more conservative as the Fund nears the target retirement date. The principal value of the Fund(s) is not guaranteed at any time, including at the target date.

TDFs are not a complete retirement program and may not provide sufficient retirement income. There may be additional fees or expenses associated with investing in a Fund of Funds strategy. Asset allocation does not guarantee investment returns and does not eliminate the risk of loss.

Conflicts of Interest: Refer to the Conflicts of Interest section of the Fund's Prospectus.